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2011

Ocean Carriers
Project Evaluation



Natalya Kashirina



Executive Summary
Making necessary changes to companys policies will produce a positive outcome in the
acceptance of the proposed lease. Income tax is the most important factor in this case. United
States 35% tax rate will not allow for a positive NPV. Therefore, new vessel must be registered
in Hong Kong in order to receive tax exemption. Ocean Carriers 15 year policy is not as
advantageous as it appears and should be ignored. Furthermore, the evaluation of the market
led us to believe that the proposed contract terms are unfavorable and should be renegotiated.
Problem Statement
New lease offer would require Ocean Carriers to invest 39 million dollars in the building of a new
Capesize vessel. However, under current operations, it is unclear if this new venture would be
profitable in the long run. The company has offices in United States and Hong Kong; however, it
does not take advantage of tax exemption it is qualified for, and instead incurs an unfavorable
35% income tax rate. In addition, 15-year policy the company follows is undesirable under
current conditions and needs to be changed.
Analysis
Under current policies an investment in a new Capesize vessel will result in an extremely
undesirable NPV and become a financial burden to the company. However, making adjustments
to some of Ocean Carriers procedures will transform this investment into a highly profitable
venture.
In 1990 Hong Kong government enacted an independent shipping registry, Merchant Shipping
(Registration) Ordinance, which states that ships owned by qualified persons or companies, and
registered on the Register established by the Ordinance have to fly the flag of Hong Kong to
receive tax exemption on profits. According to the act, qualified persons may include a company
incorporated outside of Hong Kong with established place of business in Hong Kong. In
addition, Hong Kong has entered into double taxation relief agreements with major trading
countries including United States.
A critical factor which determines the acceptance of this investment is the income tax rate Since
Ocean Carriers has offices in Hong Kong it is eligible for tax exemption. This allows the
company to legally earn profits tax-free. With United States 35% income tax rate, the NPV of
the new vessel is approximately -6.3 million dollars; implementing zero tax-rate significantly
changes this value to a much more desirable outcome of 561k dollars. Registering new vessel
in Hong Kong eliminates income tax completely allowing the company to earn greater profits,
and making the acceptance of proposed new lease profitable.
Ocean Carriers implements a 15-year policy to avoid some of the large survey expenditures
required every five years. After 15 years of operation the scrap value of a capesize vessel is
insignificant at only 5 million dollars. With 35% income tax rate, NPVs for vessels 15 years in
operation and 25 years in operation are both negative; however, the difference in NPV is nearly
1 million dollars, making 25 years in operation a better choice. Therefore, the company should
abandon 15-year policy and utilize the ship for its full life of 25 years. Table1 below shows the
difference in NPV of a vessel based on its years in operation.


Table 1


Ocean Carriers dry bulk capesize vessels are mainly used to transport iron ore and coal. Dry
bulk freight rates are expected to increase due to the strong demand for Capesize vessels and
fairly tight availability. Forecasted demand for these vessels is closely correlated with the level
of economic growth in the world. Higher level of economic activity and industrial production
generally leads to higher demand for industrial raw materials. Global iron ore production and
exports are expected to increase in the coming years. Based on this positive view of the dry
bulk industry, we have determined that the daily rates offered in the new lease contract are
underpriced and should be renegotiated.
Recommendation
After completing the analysis for each scenario, weve come to a conclusion that the proposed
new lease offer should be accepted; however, implementation of this decision is contingent on
three specific adjustments. First two changes concern the companys policies. It is clear to us
that the feasibility of a profitable outcome from this investment depends on the income tax the
company is subjected to. New Capesize vessel must be registered in Hong Kong in order to
receive tax exemption. Secondly, as seen in Table1, 15 year policy is much less profitable than
the vessels full life expectancy of 25 years and should not be applied in this case. In addition,
even though these adjustments to companys policies would create a positive return of 2 million
dollars, renegotiating the proposed contract terms will produce even higher return of 7 million
dollars. Careful evaluation of the market led us to believe that the contract rates are underpriced
and should be increased to $22,000 per day with the same escalation rate, and the term of the
contract extended to five years.







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